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December 14, 2012

Bill Gross: Fed Action Means ‘Money for Nothing’

Fed and other central banks have a policy of ‘writing checks,’ says PIMCO's bond guru

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“What really happens, and this is critically important, is that the Treasury issues bonds and the Fed buys them and then it remits interest to the Treasury," Bill Gross (left), a PIMCO co-founder and portfolio manager, told Bloomberg Television on Friday. "It basically means that the Treasury is issuing debt for free … Inflation is one of the complications."

Here, in Gross' own words, are his thoughts about the current state of the U.S. bond market:

Gross on Wednesday's move by the Federal Reserve:

"Basically, the Fed's policy has been, and other central bank's policies have been, over the past few years to write checks. Ben Bernanke, back in 2002, when he was the governor, basically told us in the first one or two pages of his scripted speech that the quantitative maneuvers that he anticipated going forward were essentially costless. Those were his words. He is correct. This is critical and important, what really happens is that the Treasury issues funds, the Fed buys them and then it remits interest to the Treasury quarterly or over time. It basically means that the Treasury is issuing debt for free."

On what the economic complications will be:

"There are those, and we are amongst them, that believe that inflation is one of the complications. It has not happened yet. We are well below 2%. The Fed is comforted by that. Ultimately, if you write checks for free and if it is costless to finance a fiscal policy that is well into a deficit figures, then, yes, that is an inflationary moment to the extent that the private sector gets some animal spirits and takes that bait."

On whether he and Mohamed El-Erian have been invited to Washington:

"Not frequently. Mohamed is a great ambassador and he picks up the phone frequently, I think, but we have not been invited to these meetings. I find it a little strange with our $2 trillion asset base. We did participate in 2008 and 2009 and the commercial paper program for the Fed and for the mortgage program. We have been in there helping out, so to speak. We haven't been part of the meetings. That's our style. We're on the West Coast. We sort of like breathing the fresh air and looking at the sunshine, but no invitation yet."

On advice he would give to President Obama and Republican leaders:

"I would say get together and figure out a solution. if they do not, there is a recession coming and a downgrade perhaps in terms of long-term treasury bonds. So get out of this and take care of the debt ceiling at the same time. Ultimately, the policy has to be directed towards investment spending as opposed to consumption. Mohamed and I would think that infrastructure is the key. It hasn't been mentioned up until this point. Entitlements have to go down. Taxes have to go up. Within that context, let's put whatever government spending there is to work in a productive way, as opposed to writing checks for consumption. let's make it an investment-oriented economy."

On whether PIMCO will sell more mortgages:

"We have been lightening up on mortgages, it is true. One of the reasons that PIMCO has had such a great year is because we have been anticipating what the Fed is going to do. We bought a lot of mortgages and so we are getting back to home base. It is not that we do not like the asset class, it is an excellent asset class because the Fed will be buying 40 billion of them going forward every month. So we're back to normal and we would suggest that our investors take a look at mortgages. They yield 2% or 2.5% relative to a 10 Year treasury at 1.70.

"In addition to anticipating what the Fed was going to do, it's a statement on safety. We believe that the economy is slow and will stay slow. We are not looking for a recession but we are looking for risk assets to stop bubbling, which means that spreads of corporates will probably not narrow again in 2013 and that we should be focusing on mortgages and the roll down in treasuries that provides a decent alternative to some of these corporate spreads."

On how to protect wealth with tax rates likely going up:

"First of all, municipals are an alternative. Municipals might be part of the tax package so I think an investor has to be leery at least until we see some legislation in 2013 which defines how municipals fit in. That is one way to do it. You also do it in markets outside the United States which have higher than average growth and are not subject to the higher taxes that you speak to. If you're looking for growth and for risk go outside the united states, if you're looking for substance within the united states to protect yourself, perhaps municipals, but we're focusing at the moment on treasuries and that roll down in terms of yield which gives you an added 50 to 100 basis points which gives you something."